Covenant Weekly Market Synopsis for April 26, 2019

April 29, 2019

Last Week Today: In an effort to cut off Iranian oil exports and further isolate the country, the White House announced the end of waivers that had allowed eight countries to buy Iranian oil. The price of crude initially jumped on supply concerns (Iran currently exports approx. 1.2 million barrels per day) but fell later in the week when President Trump told a crowd he placed a call to OPEC demanding they bring down the price of oil. | Former Godfather’s Pizza CEO Herman Cain withdrew from consideration for a seat on the Federal Reserve. | Viewed as a bellwether for technology and manufacturing, South Korea’s GDP unexpectedly declined 0.3% in the first quarter, another indication that synchronized global growth has given way to synchronized slowing. | Q1 GDP came in at 3.2%, though the headline value belies slower economic growth – more on the GDP release below. | The Fed convenes this week for their third meeting of the year, but a change in interest rates is extremely unlikely.

Approximately seven months after their last respective all-time-highs, the S&P 500 (+1.2% for the week) and Nasdaq Composite (+1.9%) indices both ended the week at record levels. International stocks trailed their domestic counterparts with European and Japanese stock indices eking out small gains, while China’s main equity index declined -3.4% for it’s worst weekly performance since October. After a brief period of inversion between key U.S. Treasury bond maturities (10-year/2-year and 10-year/3-mo), the yield curve has steepened over the last four weeks. Although the curve remains very flat, it has at least regained a less troubling upward sloping shape. In the commodity complex, precious metals rose (Gold +0.8%, Silver +0.4%), while Dr. Copper (-1.2%) and WTI Crude (-1.9%) declined on the week. WTI crude closed the week trading at $62.80 per barrel. The VIX Index (a measure of investor anxiety) is a low 12.7, down 50% from the beginning of the year following the financial market turmoil of Q4.

Follow the Leader. Global central banks are shadowing the Fed’s shift away from a tightening bias. Last month the European Central Bank announced a delay in their intent to raise interest rates until at least 2020. The Bank of Canada left rates unchanged for the fifth consecutive meeting last week, and surprised markets by suggesting they are open to cutting rates if necessary. On Wednesday, the Bank of Japan pledged rates would stay low until “around Spring 2020”. On Thursday, Sweden’s central bank (The Riksbank) pushed out its next rate hike until 2020 or possibly later, after signaling it would raise rates later this year only a few months ago. In light of slowing economic growth, investors have been ignoring central bankers’ tightening bias, pushing global yields lower. The amount of negative-yielding bonds in the Barclays Global Aggregate Bond Index rose more than 50% from September to nearly $10 trillion today (source Bloomberg).

Q1 Earnings Update. With nearly half of S&P 500 companies reporting Q1 earnings thus far, results are exceeding expectations as management teams did an excellent job of issuing lukewarm guidance over the last several months. In a difficult comparison to Q1 2018 (which benefited from the initiation of the new corporate tax-cuts), aggregate Q1 Earnings Per Share is tracking toward flat year-over-year. No growth doesn’t sound very good until you consider analyst consensus estimates were for Q1 earnings to contract by -2% (Source: Goldman Sachs). Earnings season continues this week with another 30%+ of S&P 500 companies reporting Q1 results.

Domestic sales only grew by 1.3%, half the pace of Q4 2018 and the slowest since Q2 2013.

Growth in inventories added 0.7% to Q1 GDP. In light of slow demand, the boost that inventories provided in Q1 will be a drag in the coming quarters as companies must clear their warehouses of the excess product before re-ordering.

Inflation-adjusted Business Fixed Investment declined from 5.4% to 2.7%.

The most substantial portion of the economy, Personal Consumption Expenditures (PCE) downshifted to 1.2% in Q1 (vs. 3.5% in Q3 and 2.5% in Q4 2018). The government shutdown and weather-related factors may have negatively impacted PCE, but we won’t know for several months as new data is released.

Headline PCE Inflation slowed from 1.5% to 0.5% and Core PCE Inflation fell to 1.3%. The GDP deflator, which measures prices of domestically produced final goods and services, fell to just 0.6%. Low Q1 inflation flattered the already weak real levels of Business Fixed Investment and Personal Consumption Expenditures.

Bottom Line: Since the Financial Crisis, Q1 has typically been the weakest quarter for growth, but that pattern is unlikely to hold in 2019. Indeed, Q1 may represent the most robust aggregate growth in 2019 as we expect full-year GDP to track between 2% – 2.5% in a continuation of the “Good, but not great” economic environment characterizing the post-Financial Crisis recovery. Regardless of the strength of the expansion, it appears to be a safe bet that it will become the longest on record when it enters its eleventh year in June.